Jean-Francois Wen

Political instability, capital taxation, and growth

Abstract In cross-country studies of economic growth, average growth rates of GDP per capita tend to be negatively associated both with the size of government and with measures of political instability. We show that a linear endogenous growth model with a very simple model of government spending and taxation, in the presence of political instability, can account for both empirical correlations. In addition, the model predicts that both correlations are intimately linked: thus greater political instability leads to both lower growth rates and a higher share of government spending in GDP.

Optimal privatization of vertical public utilities

We examine restructuring, divestiture, and deregulation of a vertically integrated public utility, (e.g., electricity), from a public finance perspective. How an optimal restructuring plan for the utility depends on the cost of public funds and on the X-efficiency gains from privatization, how the optimal degree of competition in the upstream and downstream segments are connected, and implications of privatization for consumer prices are examined. The higher the cost of public funds, the more likely the post-privatization price will exceed the regulated public utility price. The greater the X-efficiency gains from privatization, the more likely the post-privatization price will fall.

Tax Holidays and the International Capital Market

The paper shows how a tax holiday may signal to a skepticalcapital market that the future level of taxation will be moderate.After the signal has informed investors that the host countrygovernment is a low-spender, the tax profile flattens out, correspondingto a tax reform stage. Contrary to the recent literature on taxholidays, this model assumes that: the capital market is perfectlycompetitive; sunk costs are captured by a convex cost function,instead of fixed costs; taxation is distortionary, not lump-sum;and the government maximizes a welfare function rather than taxrevenue.

Inflation Welfare, and the Time-Costs of Transacting

The costs of inflation are assessed using an endogenous growth macroeconomic model in which money reduces the time-costs of transacting. Inflation reduces growth in the model, which supports recent empirical evidence. Although simulations show time-costs to be small, inflation raises these costs and affects consumption, employment, and growth margins, implying greater welfare losses than generally found in the literature. The authors estimate welfare gains of 2 percent of GNP for reductions in inflation rates from 5 percent to zero when seignorage revenues are replaced with distortional taxes. Optimal inflation rates are negative.

An Empirical Model of Tax Convexity and Self-Employment

Do progressive marginal income tax rates discourage self-employment? We assume risk neutrality to construct an implicit surtax on stochastic income relative to steady income, arising from a convex tax schedule. It is computed as part of a structural probit model with earnings equations and a tax simulator. The tax convexity variable and the net-of-tax income difference between self- and paid employment have the predicted signs and high levels of statistical significance for the probability of self-employment. A simulated flat tax reform suggests the tax effects are small.

Common and Private Values of the Firm in Tax Competition

We develop a simple model of interregional tax competition to explore how the balance between common and region-specific aspects of a projects value affects the magnitudes of tax breaks offered by governments, when the firm possesses private information on the region-specific values. We examine cases in which the tax applies to both the common and private values and to each component separately. The model predicts that when the common and observable part of the value of a project increases relative to the variance of the region-specific private values, the stringency of competition reduces the equilibrium tax rate. Conversely, if the competing regions are sufficiently different, bidding is less aggressive. One interpretation of the results is that firms that are observed to be large get better tax breaks. The intuition is closely related to the Bertrand model of differentiated product market competition. Copyright 2001 by Blackwell Publishing Inc.

A Theory of Top Income Taxation and Social Insurance

The development of the welfare state in the Western economies between 1930 and 1990 coincided with a puzzling pattern in the taxation of top incomes. Effective tax rates at the top increased sharply but then gradually decreased, even as social transfers continued rising. We propose a new theory of the development of the welfare state to explain these facts. Our main insight is that social insurance and top income taxation are substitutes for averting social confl?ict. We emphasize the role of the Great Depression as a source of aggregate risk, and argue that the rise of the welfare state can be understood as a process of exploiting efficiency gains in response to gradual technological improvements in the provision of social insurance. Our detailed arguments build on the policy histories of the United States, Great Britain, and Sweden.

Income Instability and Fiscal Progression

We construct the ratio of the post-fisc to the pre-fisc transitory component of the variance of family incomes in Canada from 1993 and 2008. The ratio measures how much the tax and transfer system attenuates market income instability. It is shown that the ratio of variances is equivalent theoretically to the concept of residual income progression. The fiscal system became less stabilizing beginning in the late 1990s, especially for families headed by main earners with less than high school education. The trend is attributable to personal income tax reforms and reductions in transfers for lower income families.

Profit Taxes and the Growth of Fringe Firms

In this paper we examine the optimal taxation of corporate profits in a multi-period limit pricing model where a dominant firm faces expansion by a competitive fringe. The optimal policy requires tax rates to vary both intertemporally and across firm sizes, and balances the benefit of fringe growth in eroding the market power of the dominant firm and the cost of displacing the dominant firms output with the higher cost output of the fringe. The results are relevant for assessing the policy of giving preferential tax treatment to small firms, as practised by several OECD countries.

A Question of Fairness: Time to Reconsider Income-Averaging Provisions

A system of progressive marginal income tax rates, as in Canada, tends to impose a greater tax burden on individuals whose incomes are irregular or fluctuate year-by-year, compared to individuals with steadier incomes of the same average value over several years. Take, for example, a person without dependents living in Ontario. Suppose she earns